Both forming an LLC and incorporating your business safeguard you by protecting your personal assets if legal action is taken against your business. They also give your business a boost of credibility by having either “LLC” or “Inc.” behind your company name. But there are differences that could make one or the other the better choice for you.
I can’t emphasize enough the importance of knowing the pros and cons of the legal structures available to you before you decide which will serve your business most effectively.
The Low-down On LLCs
Many owner-managed businesses opt to form as LLCs.
LLC owners are referred to as “members,” who each own a certain percentage of the business. Single-member LLCs are uncomplicated from a compliance and management standpoint. When you have multiple members, however, you should have an operating agreement that documents who can make decisions and how transferring membership interests should happen if a member leaves, dies, or files bankruptcy. Some states require that the remaining members dissolve the LLC under the circumstance of a member’s leaving, death, or bankruptcy.
From a tax standpoint, you can choose to have your LLC treated in one of two ways.
- As a pass-through entity, with the profits and losses of your business passed to your LLC members’ personal tax returns. If your business isn’t profitable, that will lower your personal tax obl
- As an S Corporation, whereby only salaries and wages are subject to self-employment taxes (FICA and Medicare), not company profits taken as distributions to members.
Because there are notably less formation paperwork and compliance requirements with an LLC than there are with a corporation, business owners who want legal protection and tax flexibility without a lot of complexity find the LLC structure an attractive option.
One potential disadvantage of forming an LLC, however, is that you cannot sell stock to raise capital for your business. And if you seek funding from venture capitalists, you may get turned down because many will only invest in corporations.
Insight About Incorporating
Whether S Corporation or C Corporation, the owners of corporations are called shareholders. Their percentage of ownership corresponds to their percentage of shares in the business. Unlike with an LLC, it’s typically simple to transfer shares (ownership) from one person to another. That means the business can continue onward when shareholders leave, die, or sell their shares.
With an S Corporation, a business’s income, losses, and deductions pass through to its shareholders. Typically, the shareholders report corporate income on their personal income tax returns.
Unlike LLCs and C Corporations, S Corporations are limited to 100 members/shareholders. So while they can sell stock, their potential to raise capital in that way is somewhat limited.
While S Corporations require more paperwork and ongoing compliance than LLCs, they don’t come with as much formality as C Corporations.
Tax treatment of C Corporations involves what is often called “double taxation.” A C Corp pays corporate income tax on its profits, and then its shareholders pay personal income tax on the profits they receive as dividends.
C Corporations don’t have a limit on the number of shareholders that can invest in them, and they may be more attractive to outside investors.
Because C Corporations operate as separate legal entities from their owners, they provide more personal liability protection than other business structures.
Note that potential drawbacks to incorporating as a C Corporation are the higher formation costs, extra compliance requirements, and additional oversight they are subject to.
Do Your Due Diligence, Then Decide.
With both legal and financial aspects of your business affected by your choice of legal structure, make sure you carefully evaluate your options. I encourage you to seek professional expertise and guidance, so you fully understand the advantages and disadvantages of each structure.
In the meantime, you can get off to a great start by using the CorpNet Business Structure Wizard for gaining a better idea of the structure that might work best for you.